PC Connection, Inc. (CNXN) Q2 2016 Earnings Report, Transcript and Summary

Good day ladies and gentlemen, and welcome to the Second Quarter 2016 PC Connection Incorporated Earnings Conference Call. My name is [indiscernible], and I’ll be the coordinator for today. At this moment, all participants are in a listen-only mode. Following prepared remarks, there will be a question and answer session. As a reminder, this conference call is the property of PC Inc Connection and may not be recorded or rebroadcasted without specific permission from the Company. On the call today is Tim McGrath, President and Chief Executive Officer; and Joe Driscoll, Chief Financial Officer. Any statements or references made during the conference call that are not statements of historical fact, may be deemed to be forward-looking statements. Various remarks that management may make about the Company's future expectations, plans, and prospects, constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors Section of the Company's Annual Report on Form 10-K for the year ended December 31, 2015, which was on file with the Securities and Exchange Commission, as well as in other documents at the company files with the Commission from time-to-time. In addition, any forward-looking statements represent management's view as of today and should not be relied upon as representing views as of any subsequent date. While the Company may elect to update forward-looking statements at some point in the future, the Company specifically disclaims any obligation any obligation to do so, even if estimates change. And therefore, you should not rely on these forward-looking statements as representing views of any date subsequent to today. During this call, GAAP and non-GAAP financial measures will be discussed. A reconciliation between the two is available in today’s earning release and at the Company’s website. Today’s call is being webcast, and will be available on PC Connection’s website. The earnings release is also available on the website. I would now like to turn the call over to Tim McGrath. Please proceed sir. Timothy McGrath Thank you [indiscernible]. Good afternoon everyone and thank you for joining us today to review the Company's second quarter financial results. We had a strong second quarter in a modest growth environment. We were able to increase earnings per share due to solid sales growth and a significant improvement in gross margin percentage. We also acquired Softmart on May 27, which we will discuss in more detail in a few minute. As we review our results, please note that unless otherwise stated all of our second quarter 2016 comparisons are being made against second quarter 2015. Also note that Softmart’s results for the month of June are included in our Q2 2016 results based on the date of acquisition. Consolidate net sales year-over-year increased by $49 million or 7.7% to $676 million. Gross profit dollars in the quarter increased by 13% to $94 million. Consolidated gross margin increased to 13.9% a substantial increase over the 13.2% in Q2 2015. SG&A excluding acquisition cost, restructuring charges, and amortization of acquired intangible assets increase this quarter $71.9 million from $53.1 million. This increase due to higher variable compensation from increased gross profit, one month of Softmart SG&A and the hiring we have done over the last year in sales and technical areas. Diluted earnings per share increase from $0.44 to $0.47. Adjusted earnings per share, excluding acquisition and restructuring charges and acquisition related amortization increased to $0.49 per share. I would now like read the Softmart acquisition into detail. On May 27, we completed the acquisition and we are very excited about the opportunities this presents. Softmart was founded 35-years ago which is approximately the same time the PC Connection was founded. The company had developed a strong Microsoft services, in addition its providing hardware, software and services their Microsoft business combined with the existing PC Connection business makes us one of the top Microsoft partners in the world. Softmart has created a strong Microsoft services practice and its developed software licensing optimization tools and processes. This is how thousands of customers streamline and optimize their software usage and licensing requirements. We believe that the combination of the tools they have created, plus the optimization programs we have developed gives us some of the deepest capabilities in the industry for software licensing, deployment and management. Softmart has also attained Tier-1 cloud solution provider status with Microsoft. This gives us more robust cloud services capability in addition to the ability to provide cloud offerings and services electronically. This is an important transition as our customer change the way they procure and utilize cloud services. In addition, we believe that Softmart customers will benefit from our deep relationship with other manufacturers in terms of pricing, logistic and technical expertise, and end-to-end solutions. There is a good cultural fit between Softmart and PC Connection, we have already started the profit of analyzing and taking advantage of best practices at both companies. And now, I would like to turn the call over to Joe Driscoll to discuss the results of our segment and financial highlights. Joe.

Thanks Tim. In regards to Softmart, we will not be breaking out their results separately, because they have only one month included in our quarterly numbers based on the date of acquisition. Softmart’s annual revenues are in the $200 million range. Sales for our SMB segment which serves small to medium size businesses increased by 8.3% to $281 million, this includes all of Softmart's June revenues since most of their customers fall into our SMB definition. Gross margin was very strong as they increased by 78 basis points to 16.2%, led year solid performance in advanced solution categories such as software and networking. Sales by our large account segment increased by 12% to $260 million, this significant growth was primarily due to strong software revenues in addition to strong healthcare performance. Gross margin in Q2 was 12.4% consistent with prior year. Sales in the public sector segment, which includes sales to government and education customers, remain flat at $136 million. Gross margin for the public sector segment was strong, it increased 149 basis points to 11.9%. Product mix drove the margin improvement as gross profit dollars for the public sector were up 13.7% over the last year. Our healthcare vertical, which includes customers and all three of our business segments, had a very strong quarter with 19% growth in revenues. We continue to focus on connecting healthcare customers with customized solutions in the specialized vertical, which is projected to be a growth area for IT spending for the foreseeable future. In Q2, we incurred 841,000 of acquisition and restructuring cost, this charge includes professional fees related to the Softmart deal, severance related to internal restructuring activities and duplicate cost incurred in our office move from Itasca, Illinois to Schaumburg, Illinois. There could be additional restructuring cost incurred in Q3 as we continue to take our hard look at our expense structure. In addition, we will breakout amortization of acquired intangible asset each quarter. The preliminary values assigned to Softmart intangible assets will result in a quarterly amortization charge of approximately 300,000. In Q2, the amortization was 83,000 because there is one month of activity. Overall, our bottom line performance exceeded the prior year. Earnings per share excluding one-time charges and amortization of acquired intangible increased to $0.49 per share up from $0.44 last year. Trailing 12 months adjusted EBITDA increased $93.1 million. Our balance sheet is in good shape. The Q2 2016 cash balance of $47 million is lower than Q1s balance due to the $34 million we paid for Softmart plus we had a very strong revenue performance in June, which in the near term reduces our cash balance due to the increase in working capital. Our goal with excess cash is to maximize shareholder value while maintaining financial flexibility. We continue to assess M&A opportunities and other capital allocations such as dividends and stock buybacks. As a reminder, we still have $17.8 million in previously authorized share repurchases. I'll now turn the call back over to Tim to discuss current market trends.

Thanks Joe. Our second quarter results reinforce the importance of product mix and advanced technologies on our overall growth profit margin. We believe that our plan is on-track and that our strategy is working. Despite the softness in overall IT spending, we were able produce strong gross margin and therefore grow earnings per share. Looking ahead at the rest of the year, current industry growth projections for 2016 are in the 3% range. Our goal is to grow faster than the market by taking share, we are highly focused on the company's mission, connecting customers with technology solution, while continuing to grow the bottom line faster than the top-line. We are also focused on advanced technologies and we are investing in complex areas in order to help our customer drive their business outcomes through IT investments. For example, our software business continues to grow including cloud virtualization and security, we are seeing growth in the converged infrastructure and we also continue to target vertical market such as healthcare, which grew 19% in the second quarter 2016. We believe that Softmart acquisition will be accretive for the company and will be a critical part of our ongoing strategy to connect customers with technology. Many of our customers are defining and improving their digital strategy, which is enabled and defined by software. We believe that the combined organization will be a leader in its ability help customers define, manage, and deploy software solution. From our financial perspective, as we integrate the two businesses there will be opportunity to increase sales to existing customers and win new business as a result of expanded capabilities. The purchase was funded from cash on hand and we still have a strong balance sheet with no debt. Softmart is expected to add approximately $100 million in revenue for the last six months of 2016 and is expected to be modestly profitable with Q4 being slightly higher than Q3 in sales and in profit. We believe our business model is more relevant than ever as we help our customers navigate through the technology that’s more complex and more disruptive. We also believe that our balanced portfolio of customers, suppliers, product and solution has helped us to deliver solid results. Our goal is to continue to deliver sustain and consistent performance. We will now entertain your questions. Operator.

Thank you [Operator Instructions] And our first question comes from Adam Tindle from Raymond James. Your line is open.

Okay thank you and good afternoon guys. Just first question, I understand you are not breaking out Softmart, but you did have strong large account revenue growth and understand that Softmart is primarily as SMB, so probably not as much of an impact there. Could you give us more color on that large account revenue growth given that this tends to be an area of strong cloud adoption.

So Adam thanks, we did a terrific performance in the enterprise base, as you know that really is project outcome-based, solutions-based rollout and we were very strong in the enterprise, in particular we have really software growth and that was the big driver of the overall growth. In addition to the enterprise healthcare was really strong.

Okay and on the product side servers stood out, I think that was down double-digit year-over-year, can you give us sense of what is driving this and do you expect to rebound?

Yes, so thanks. So you probably have to look at that statement in it’s entirely of really what we are seeing out there is we’re seeing our customers evaluate options, a lot of technology on the horizon, as you know it’s a Broadwell and the conversion to Windows 10. In addition, I think customers were evaluating our [indiscernible] solutions. And finally, we extraordinary growth in virtualization and as you know when you start to look at the numbers we were driving in terms of virtualization and security. We think that really had an impact, but most importantly, it’s project driven and so a lot of that also is body based on the particular project and roll outs, we are doing at that time. So we've got a big focus on advance technologies and we’re very confident that the server business will be just fine.

Okay and you talked about how, obviously the gold years to grow the bottom line faster than the top-line, but we had a quarter here where SG&A slightly outpaced gross profit dollar growth year-over-year. why is this happening and should this continue? I know you mentioned additional restructuring costing of possibility.

Yes so first point is that we are constantly looking at our expense structure and as we see for many other technology companies, we know there are areas we need to invest in, in the future. And in order to afford that you have got to kind of look at your legacy areas. So that’s certainly something that’s an ongoing project for us. I think the numbers this quarter might be a little skewed because of the Softmart numbers being in there, they are only there for a month, but really Softmart has higher gross margin percentage than I guess traditional PC Connection and it also has a higher SG&A as a percent of sales than sort of our traditional P&L. So you have got some element that flowing through the SG&A for Q2 as well. But other than that, you are going to see higher SG&A, SG&A goes up as a function of gross profit dollars, those gross profit dollars go up, you are going to have higher variable SG&A. And really over the last year, we've hired a number of sale people and technical people, really to try the drive future growth.

And with those technical people, are you seeing a difference in the variable cost there that’s affecting the model in some way or are you still anticipating gross profit dollars outgrow SG&A and that’s kind of the mantra?

Yes that would definitely be the game plan there. The long-term goal is that by adding more technical people, we are going to be more successful at selling more advanced solutions, which carry higher margins. So overtime, you should see a gradual increase in gross margin percentage and you might also see a slight pickup in SG&A percentage as well.

Understood. Thank you.

Thank you Adam.

Thank you. And our next question comes from William Gibson from Roth Capital Partners. Your line is open.

Yes. You mentioned studying best practices about companies and I know we are early in that stage, but if you were are on a cross a thing or two with Softmart that you are going to incorporate into your business?

Bill thanks. Yes, absolutely that was a big part of the attraction for Softmart. There are a number of things. To begin with, the processes and their capabilities around software, their approach to that, helping customer evaluate, assess what they have, helping them deploy what they have in a way that’s impactful and generally it’s a real cost savings for the customer. Is an example of best practice will melt with we call our MLO and SLO our Microsoft licensing optimization and the software optimization. Those two best practices coming together are really going to be impactful for example.

Yes. And healthcare good a growth across all the segments. What are some of the things that are going on in healthcare, I mean exactly what are you doing there?

Well thanks. We are pleased with the growth that we are seeing, right now in Q2 I think market conditions, the meaningful use guidelines really drove a lot of growth for the quarter, clearly the large GPOs in the enterprise space did there very well in the quarter. But we are also very optimistic about the future, as you know Bill, we have a focus on vertical markets and we see the healthcare vertical as being probably the leader in growth. Going forward, there are number of drivers that will continue not the resell which is the round of the HIPPA audit, which are really going to cause many of our customers to go into kind of full force as they look at their IT component. So we are excited about that, we are seeing a lot more [retail] (Ph) at medicine and as I mentioned, we are doing much better with GPOs.

Good, and what are some other verticals you are potentially thinking about or breaking out?

So we are very focused on four vertical markets and the caveat and my public sector group would want me to mention this right away. We think about public sector, we think of that as vertical, but anyways education is very important vertical. So that’s ongoing of course and healthcare is ongoing, but we are also really looking at the retail space, the in and out of things driving so many changes there. Looking at the manufacturing space with all the changes that the artificial intelligence, robotic, IOT and eventually 3D printing or driving there and the financial space is really right for an upgrade, there are many legacy systems out there that are standalone and of course security a big driver in financial. So those really are the four verticals in addition to the public sector as a vertical and education there.

Okay good. Thank you.

Thank you.

Thank you. And our next question comes from Anthony Lebiedzinski from Sidoti and Company. Your line is open.

Yes, good afternoon and thank you for taking the questions. So actually just a follow-up on the last question. Can you give us a sense of how big these markets are, as far as education, retail, manufacturing and financial, just wanted to understand what is the opportunity that you may have in each of these verticals?

Yes. So we look at the entire U.S. market as being around $200 billion, some people have it a little higher or little lower, but around $200 billion. So between those four verticals, you are probably talking about half of that number and then you get a another big chuck from the education and government and then a series of other industries spreading around the rest. So it’s a big opportunities for us.

Got you okay and then Joe, you also mentioned that you had a strong revenue performance in June. Was that mostly because of Softmart or was there other things going on and if so, if you could just expand on that that would be great?

Yes. You know June is the quarter-end and a lot of our customers and lot of our suppliers as well and so there is sort of a natural rush to the finish line to get in as many deals as you can by the end of June. So it kind of happens that way every June. Some of our major supplier like Microsoft, for example, June 30 is their fiscal year-end, so there is a big focus on closing software deals. So it kind of happens that way many years.

Got you okay and then lastly, one of the other question was about gross margin and SG&A, so as we saw in this quarter, your gross margins was up, your SG&A as a percent of sales were up. At what point would you say that you will be able to see your operating margins grow meaningfully as you start to leverage those SG&A?

Yes. It’s a great question. Really our goal is to try to grow to the operating margins every year at some meaningful number, let’s say 10 to 20 basis points a year. We believe if we grow the top-line and above market rate, we improve our gross margins as a percent of sale and we try to hold the line as best we can as SG&A as a percent of sales, you are going to get some operating income improvement as a percent of sales every year. So we are not targeting 50 basis points of operating income improvement on an annual basis, but we think something like 10 to 20 basis points is absolutely achievable. So that’s sort of what we are targeting right now.

Okay, that’s fair. Alright, thanks very much.

Thank you, Anthony.

Thank you. This concludes today’s Q&A session. I would now like to turn the call back to Mr. McGrath for closing remarks.

I would like to thank all of our customers, vendor partners and shareholders for their continued support, and our dedicated coworkers for their efforts. I would also like to thank those of you listening to our call this afternoon. Your time and interest in PC Connection are appreciated. Have a great evening.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.